Ivan Yates writes that we will have to enter the EU Stabilisation fund because the bond lenders will tell us take a hike. – He’s right.

Our fate is already sealed – now stand by for the nuclear option
By Ivan Yates
Thursday, November 04, 2010

THIS week’s visit by Olli Rehn from Brussels sets the domestic mood music for the Government’s draconian budget.
Financial discipline and consequent austerity is being demanded from Brussels. We’re not getting the full story. The fiscal difficulties of Ireland that have led to our dependence on the European Central Bank (ECB) have consistently been understated. It’s not in our Government’s or ECB’s interest formally to announce Ireland is beholden to the EU Stabilisation Fund. It is obvious that the bond markets are not going to fund us at sustainable rates.

The Central Bank and ECB are ultra-secretive about the extent to which they have underwritten the finances of the state and our financial institutions. €40bn of NAMA bonds were transparent. The recapitalisation and deposit base of AIB and Bank of Ireland is less clear. Reports suggest ECB involvement of up to €260bn. The National Treasury Management Agency (NTMA) is due to re-enter the bond market early next year, with Government cashflow requirements of at least €20bn. Perhaps a quarter of this needs to be raised in the spring. An abortive bond launch places us in the same dilemma as the Greeks last April. Mutual denial exists between Dublin and Brussels about the inevitability of our fate.

The politics of the situation is taking precedence over the ultimate truth. Fianna Fáil is determined at all costs to avoid an indelible stain on their political CV that an IMF/EU bailout happened on their watch. They would prefer a general election, change of government and consequent external intervention. Hairshirt savagery of expenditure cutbacks and extra taxation is preferable to final acknowledgement of failure to run our own affairs. The party, founded on an ethos of independent sovereign republicanism, abhors the humiliation of relinquishing budgetary power outside the state. This delusion is matched in Europe.

We joined the euro in January 1999. Rules for the eurozone were laid out in European Monetary Union (EMU). The cornerstone of the currency was the stability and growth pact. While the 16 member states have a single currency, unlike the US dollar zone, we do not have an integrated federal government, Federal Reserve and unified annual budgets.

This political project presumed convergence of economic policy, not previously tested. In 2000/2001 the EU Commission merely chided Charlie McCreevy about risks of our property and credit bubbles. He told them bluntly to mind their own business. When France breached the budgetary rules in 2005, President Chirac evaded sanction.

The elephant in the room? One size has not, does not and will not fit all of the

eurozone’s economies. The hard currency stance of the German Bundestag, with a zero inflation outlook, runs counter to economic history of other states. Over four decades, Ireland, Britain, Spain, Portugal, Greece and Italy have had to devalue their currencies to restore competitiveness.

Adjustments facilitated economic recovery and growth. Meanwhile, the Deutschmark incrementally increased in value. These divergent strategies are at the heart of the euro’s problems.

EMU rules state unambiguously in article 125 of the treaty “no bailout” was permissible for a member state. There is no procedure to kick a country out of the euro. Contradictions in the economic governance within the euro finally came to a head at last week’s summit of EU leaders. Angela Merkel demanded Lisbon Treaty changes and the removal of voting rights from recalcitrant states. The immediate dilemma is the legal basis for the EU bailout fund. An interim solution for Greece was to provide €60bn under article 122, which provides for natural disasters such as a tsunami – hardly appropriate.

There is a common interest in putting the EU stabilisation fund on a firm footing as a permanent rescue mechanism.

Eurosceptics, especially Anglo-Saxons, have stated that the single euro currency is unsustainable. They have been derided as cynics with a political agenda in support of an independent sterling. These divisions within the EU are mirrored by another current debate on economic discipline.

A majority of MEPs want to increase the EU budget of 2011 by 5.9%. British prime minister David Cameron and 12 other leaders seek to limit this to 2.9%.

The key point is that PIIGS states are reaching a point of debt default. Official recognition of this amounts to orderly insolvency. Formal acknowledgement of debt restructuring or forgiveness completely undermines Germany’s currency. Olli Rehn’s job is to paper over these cracks. He must convince the Eurocrats that the Irish problem is rectifiable and manageable. The alternative consequence is a two-tier currency. Ireland’s interest is to combine with Portugal, Greece and Spain to confront the realities of peripheral economies. Rest assured this won’t happen because of false, misplaced pride.

Some of Brian Cowen’s recent comments are truly frightening. He stated over the weekend the Government has adequate cashflow finance until next July. Any company facing refinancing with banks knows it is disastrous to leave it until a final deadline before securing roll-over resources. You cannot raise finance under pressure of an imminent deadline. The surest way to breach covenants is through any delay in procuring capital. Reassertive rhetoric that Ireland won’t rely on an IMF/EU bailout is worthless.

IF we have learned anything over the past two years, it is that you don’t get prior notice of U-turns. If the Government did plan to avail of an EU ‘dig-out’, it wouldn’t tell you. There are no advance warnings. The only clue is to listen to credit rating agencies and bond market turbulence.

The key question is not if, but when, the game will be up, with official recognition of our recourse to a bailout. We should now seek to cut a four-year overall deal with an agreed cost of finance (preferably less than 5%) and adequacy of the total amount required (€80bn).

This is the silver bullet towards our financial stability. What will be the final trigger? The full embedded losses in our banks may be €16bn greater than currently anticipated. The extra recapitalisation of AIB, Anglo and Bank of Ireland may tip us over the edge. The double dip depression of a further contraction of Irish GNP in 2011 may lead to an acknowledgement in Frankfurt that the cure is as bad as the disease. There is only so much deflation any economy can endure over four years.

It’s time to move the game on. The sum total of saving our banks and rectifying Bertie’s splurge of the structural deficit was enough to sink the nation’s finances. Life goes on. The loss of sovereignty need not extend to reputational damage to the real economy. Key components of Ireland Inc such as our traded sectors of food, pharma and ICT exporters, the IFSC, and the IDA’s programme of foreign direct investment cannot be debased by handfuls of reckless developers, greedy bankers and comatose politicians. Rehn’s resolution of our budgetary crisis needs to reflect more than fiscal correction in Dublin. The euro requires the elasticity of formal rescue architecture to sustain itself in its present form. While the PIIGS must restore fiscal sanity, they cannot be slaughtered for the benefit of a narrow Fuhrer inflexibility.

This story appeared in the printed version of the Irish Examiner Thursday, November 04, 2010

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